JAPAN - ABE (Asset Bubble Evaluator) Index

Credit Suisse Created An 'Asset Bubble Evaluator' Index In Honor Of The Prime Minister Of Japan 06-14-13 Credit Suisse via BI

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BONDS - Reactive Panic Mode to TAPER

US Bonds In "Panic" Mode 06-13-13 Credit-Suisse vai ZH

Based on Credit-Suisse's Panic-Euphoria model of risk appetite, US bond markets are on the verge of the short-term capitulative "Panic" mode. Each time we have reached this level of 'selling' in the last 6 years, Treasury yields have compressed significantly. At the same time, equity risk appetite remains bearish and US credit risk appetite has resumed its decline (but relative to Treasuries they are significantly over-sold). Not a pretty picture...

Bonds hit "Panic" levels of risk appetite...

but Equity risk appetite drifts bearishly...

and Credit risk appetite signficantly weaker...

but the sell-off in High-Grade and High-Yield bonds has been remarkable relative to historical precedent...

As Citi notes,

Investors fear the 1994 redux trade, are looking at ways to short markets that may be vulnerable to rising rates, including credit. But in total return terms the credit space has already suffered quite dramatically. The chart below shows that the high-grade and high-yield markets are down 3.2% and 1.7%, respectively, since the Treasury backup began in early May, which is far more severe than what normally occurs when rates rise (annualized long-term average of +0.1% and +11.4%, respectively).

It may not be fully priced in yet, but at this point the rates trade may really boil down to how quickly Treasury yields rise further.

Charts: Credit Suisse and Citi

CHINA - Potentially De-Stabilizing Cash Crunch

China's Cash Crunch 06-14-13 WSJ

A surge in money-market rates points to growing stress in China's financial sector.

The overnight borrowing rate in China's money markets rose to 9.6% last week, a record high, and was still high at 7% as of Friday. The sharp increase reflects problems with liquidity management caused by China's overextended banks and growing wealth-management sector.

With a weak branch franchise, China's small banks are perennially starved of deposits. Wealth-management products—short-term investments that offer some of the security of a deposit but higher returns—help them attract funds to expand their business. WMPs grew to 7.1 trillion yuan at the end of 2012, from virtually nothing a few years ago.

So far, so good. But with a mismatch between short-term liabilities and long-term assets in WMPs, banks are sometimes forced to tap the money market for funds to repay investors. One measure of that is turnover in the money market, which more than tripled from 2007 to 2012 according to data from the People's Bank of China.

The surge in money-market rates isn't driven solely by the growth of WMPs. Tax season and a three-day holiday, both of which add to demands on liquidity, also played a part. Capital inflows may also have slowed, reflecting growing risk aversion in global markets. Rumors of a money-market default also pushed rates higher.

Nor does the surge represent an imminent crisis for China's financial system. With 19 trillion yuan in deposits held in reserve, China's central bank has ample resources to ease liquidity constraints if it wishes. If sharply higher borrowing costs in the money market encourage China's banks to manage their balance sheets more conservatively, it could even be a positive.

But with concerns about China's growth are mounting, a cash crunch in the financial system—which drives up the cost of borrowing—isn't well-timed. And with slowing growth adding to existing strains on China's overstretched financial system, the current surge in money-market rates likely won't be the last.

EMERGING MARKETS - The Impact of "TAPER"

Can The World Afford Higher Interest Rates? 06-14-13 James Gruber, Asia Confidential

That’s the end of QE tapering talk then? Not quite, but it should die down somewhat, give U.S. Fed Reserve conduit Jon Hilsenrath’s latest kiss-and-tell article in The Wall Street Journal. Thankfully, it might also stop all the blather about the U.S. and global economies recovering (they’re not) and this being the end of the bond bull market (premature). What most investors fail to realise is that developed markets, including the U.S., simply can’t afford a normalisation in interest rates: higher rates on government debt would crush their economies. This means QE tapering is highly unlikely and the current money printing experiment will only end when investors lose faith in government bonds. Where getting closer to that end game, but we’re not there yet.

If the above is right, we may be in for a prolonged period of volatility where investors expect QE to be cut back, it may indeed get cut back at some point, only to increase again when it’s recognised that any normalisation in interest rates will create huge problems. For emerging markets such as Asia, it’ll mean increased volatility, although I’d argue the past week’s stock market moves are reverting back to normal from an abnormally tranquil period over the past 3-4 years. This will create some opportunities, but be aware that the odds still favour a bond market crash at a later date.

What’s behind the past week’s action?
What explains the tumultuous market action of the past week? Put simply, there have been escalating fears that U.S. Federal Reserve will cut back on its US$85bn a month stimulus program. This has led to rising U.S. bond yields over the past month, thereby putting upward pressure on yields around the world.

Cutting back on QE would mean reducing the printed money that the Fed has been using to buy bonds. That would result in less liquidity, less money in the financial system. The printed money has helped support asset prices, particularly stock and bond markets. Less liquidity would reduce this support.

Much of the printed money had leaked into areas offering the best growth prospects, primarily emerging markets such as Asia. This led to some spectacular stock market performance, especially in South-East Asia. Naturally, talk of QE cutbacks hit the best performing, less liquid markets such as Thailand, the Philippines and Indonesia especially hard.

Japan is another matter. Stimulus equivalent to 3x the U.S. as a proportion of GDP and an inflation target of 2% has resulted in manic action across Japan’s stock, bond and currency markets. The yen has snapped back after being oversold, but remains extremely vulnerable given the stimulus policies of the Bank of Japan (BoJ).

Meantime, Japan’s bond market has investors fleeing due to a 2% inflation target almost guaranteeing them large losses and a central bank intent on keeping yields low to prevent interest being paid on government debt spiralling out of control. Investors are starting to realise that the government may not win this battle.

There is an alternative view: that the reason for the recent Japanese volatility is that the BoJ is backing away from its inflation target and stimulus efforts. It’s a laughable notion put forward by seemingly respectable commentators (see here). It ignores the fact that if the BoJ’s efforts succeed, rising inflation will eventually lead to rising bond yields and interest rates, which will kill the Japanese economy (see here for my previous article on this).

Later in the week, of course, the Fed came to the market’s rescue. Via its Wall Street Journal mouthpiece Jon Hilsenrath, the Fed essentially tip-toed back from earlier suggestions that it would soon reduce QE. Here’s what Hilsenrath had to say:

“The chatter about pulling back the bond program has pushed up a wide range of interest rates and appears to have investors second-guessing the Fed’s broader commitment to keeping rates low.

This is exactly what the Fed doesn’t want. Officials see bond buying as added fuel they are providing to a limp economy. Once the economy is strong enough to live without the added fuel, they still expect to keep rates low to ensure the economy keeps moving forward.”

Below is the U.S. 10 year government bond yield, courtesy of Yahoo.

The maths against higher rates
Amid all the hoopla about whether the Fed will cut stimulus or not, investors (and the mainstream media which covers them) seem to be ignoring a more fundamental issue: can the developed world cope with a normalisation in bond yields and thus interest rates?

To answer this question, let’s crunch some numbers. Bond guru Jeff Gundlach has looked at the impact of higher rates on the U.S. and he doesn’t like what he sees. He suggests that if interest rates in the U.S. normalise and increase 100 basis points annually over the next five years, the interest expense on government debt would rise from US$360 billion last year to US$1.51 trillion.

To put this into perspective, the recent U.S. government cutbacks which many worried would tip the economy into recession totalled just US$85 billion. Any normalisation in rates would result in brutal cutbacks to government programs, seriously impacting the economy.

For another example, we can look at Japan. As I’ve stated on many occasions, if rates rise to just 2.8%, interest on Japanese government debt would be the equivalent of 100% of government revenues.

The implications of higher bond yields and higher interest rates would go well beyond government debt though. Other countries with fewer government debt issues would suffer too. For instance, my native Australia is relying on the property sector (a bubble slowly deflating) to pick up some of the slack from a mining sector which is getting hammered by a slowing China. Any rise in Aussie rates would quash any hopes of a housing recovery (even if it was highly unlikely to happen anyway).

In Asia, a normalisation in rates would have a broader impact. Higher rates and tighter money would hit elevated asset markets across the board, including the stock, bond and property markets. Those which have benefited most from the low rates and subsequent money inflows, such as South East Asia, would be hurt most. In effect, the past week would be a taste of things to come.

A bond crash will have to wait
If I’m correct, central banks can’t afford to turn off the stimulus tap. If there are any signs of rising bond yields, these banks will print more money to buy bonds and keep the yields down. In other words, you shouldn’t expect less stimulus going forward, but more.

Central banks can keep this game going for a long time, but there will come a point when the bond markets will say enough is enough. As I wrote in an article on Japan recently:

“In many respects, Japan is the template for what’s to come in other developed markets. After an enormous credit bubble which burst in 1990, Japan has refused to restructure its economy in order for it to grow in a sustainable manner. Instead, it’s chosen the less painful route of printing money to try to revive the economy and reduce debts in yen terms…

… The trouble with this is that there comes a point where bond investors lose confidence in the ability of the government to repay the money. These investors then refuse to rollover government debt at low rates. When bond markets dry up, they normally do so quickly. The current wobbles in the Japanese bond market can be seen as a prelude to this endgame.

Though Japan has escaped its day of reckoning for a long time, other developed markets are unlikely to be as lucky, given the extent of their indebtedness and continued commitment to flawed policies.” 

What it means for Asia
Investor reaction to recent market volatility in Asia has been fascinating to watch. It’s almost as if investors have forgotten that emerging markets, and particularly Asia, experience sharp spikes and dips on a regular basis. It’s a classic case of an investor bias known as recency bias, which is essentially extrapolating from recent events into the future.

The reason that I say this is that when I worked in South-East Asia for three years (2006-2009), the volatility experienced during recent weeks was the norm rather than the exception. And colleagues back then who’d been through the Asian crisis thought that I’d experienced little of the volatility that South-East Asia had to offer!

The recent volatility though is likely to become the norm again. Any hint of less QE will see hot money leave Asia, only to come back when it becomes clear that stimulus should be here to stay.

Last week, I suggested the rout in emerging markets would soon result in some opportunities in Asia. I didn’t expect the rout to become an avalanche so soon, however.

There was some pushback to one of my top picks being the Indian market (Indian friends and subscribers seem to be the most pessimistic about their country’s prospects!), particularly as the rupee hit all-time lows versus the U.S. dollar. If my thesis on QE tapering being a head fake is correct, then the rupee should stage a short-term rebound.

As for the many problems that India faces, such as the current account deficit, I do acknowledge that the country still has significant issues. The question is whether these problems are well-known and factored into the stock market. I’d suggest that they largely are and the incremental positives mentioned last week are not.  

As for the other potential opportunity which I identified, Thailand, it’s been getting pummelled as per other South-East Asian countries. Keep in mind though that the country is in the best shape that it’s been in a long time. Thailand has a stable government, strong investment cycle, positive policies such as redistributing incomes from the capital to rural areas as well as battle-hardened companies who’ve seen politicians and crises come and go. Combined with reasonable valuations, particularly among bank and energy stocks, Thailand stands out as a sound, long-term investment story. 

CRONY CAPITALISM - How America Lost its Way!

How America Lost Its Way 06-07-13 Niall Ferguson, WSJ

It is getting ever harder to do business in the United States, argues Niall Ferguson, and more stimulus won't help: Our institutions need fixing.

Not everyone is an entrepreneur. Still, everyone should try—if only once—to start a business. After all, it is small and medium enterprises that are the key to job creation. There is also something uniquely educational about sitting at the desk where the buck stops, in a dreary office you've just rented, working day and night with a handful of employees just to break even.

As an academic, I'm just an amateur capitalist. Still, over the past 15 years I've started small ventures in both the U.S. and the U.K. In the process I've learned something surprising: It's much easier to do in the U.K. There seemed to be much more regulation in the U.S., not least the headache of sorting out health insurance for my few employees. And there were certainly more billable hours from lawyers.

This set me thinking. We are assured by vociferous economists that economic growth would be higher in the U.S. and unemployment lower if only the government would run even bigger deficits and/or the Fed would print even more money. But what if the difficulty lies elsewhere, in problems that no amount of fiscal or monetary stimulus can overcome?

Nearly all development economists agree that good institutions—legislatures, courts, administrative agencies—are crucial. When poor countries improve their institutions, economic growth soon accelerates. But what about rich countries?

If poor countries can get rich by improving their institutions, is it not possible that rich countries can get poor by allowing their institutions to degenerate?

I want to suggest that it is.

Consider the evidence from the annual "Doing Business" reports from the World Bank and International Finance Corporation. Since 2006 the report has published data for most of the world's countries on the total number of days it takes to start a business, get a construction permit, register a property, pay taxes, get an export or import license and enforce a contract. If one simply adds together the total number of days it would take to carry out all seven of these procedures sequentially, it is possible to construct a simple measure of how slowly—or fast—a country's bureaucracy moves.

Seven years of data suggest that most of the world's countries are successfully making it easier to do business: The total number of days it takes to carry out the seven procedures has come down, in some cases very substantially. In only around 20 countries has the total duration of dealing with "red tape" gone up. The sixth-worst case is none other than the U.S., where the total number of days has increased by 18% to 433. Other members of the bottom 10, using this metric, are Zimbabwe, Burundi and Yemen (though their absolute numbers are of course much higher).

Why is it getting harder to do business in America? Part of the answer is

excessively complex legislation.

A prime example is the 848-page Wall Street Reform and Consumer Protection Act of July 2010 (otherwise known as the Dodd-Frank Act), which, among other things, required that regulators create 243 rules, conduct 67 studies and issue 22 periodic reports. Comparable in its complexity is the Patient Protection and Affordable Care Act (906 pages), which is also in the process of spawning thousands of pages of regulation. You don't have to be opposed to tighter financial regulation or universal health care to recognize that something is wrong with laws so elaborate that almost no one affected has the time or the will to read them.

Who benefits from the growth of complex and cumbersome regulation? The answer is: lawyers, not forgetting lobbyists and compliance departments. For complexity is not the friend of the little man. It is the friend of the deep pocket. It is the friend of cronyism.

We used to have the rule of law. Now it is tempting to say we have the rule of lawyers, which is something different. For the lawyers can also make money even in the absence of complex legislation.

It has long been recognized that the U.S. tort system is exceptionally expensive. Indeed, tort reform is something few people will openly argue against. Yet the plague of class-action lawsuits continues unabated. Regular customers of Southwest Airlines recently received this email: "Did you receive a Southwest Airlines drink coupon through the purchase of a Business Select ticket prior to August 1, 2010, and never redeem it? If yes, a legal Settlement provides a Replacement Drink Voucher, entitling you to a free drink aboard a Southwest flight, for every such drink coupon you did not redeem."

This is not the product of the imagination of some modern-day Charles Dickens. It is a document arising from the class-action case, In re Southwest Airlines Voucher Litigation, No. 11-cv-8176, which came before Judge Matthew F. Kennelly of the District Court for the Northern District of Illinois. As the circular explains: "This Action arose out of Southwest's decision, effective August 1, 2010, to only accept drink coupons received by Business Select customers with the purchase of a Business Select ticket on the date of the ticketed travel. The Plaintiffs in this case allege Southwest, in making that decision, breached its contract with Class Members who previously received drink coupons," etc.

As often happens in such cases, Southwest decided to settle out of court. Recipients of the email will have been nonplused to learn that the settlement "will provide Replacement Drink Vouchers to Class Members who submit timely and valid Claim Forms." One wonders how many have bothered.

Cui bono? The answer is, of course, the lawyers representing the plaintiffs. Having initially pitched for "up to $7 million in fees, costs and expenses," these ingenious jurists settled for fees of $3 million "plus costs not to exceed $30,000" from Southwest.

Canada's Fraser Institute has been compiling an "Economic Freedom" index since 1980, one component of which is a measure of the quality of a country's legal system and property rights. In the light of a case like the one described above, there is nothing surprising about the recent decline in U.S. performance. In 2000 U.S. law scored 9.23 out of 10. The most recent score (for 2010) was 7.12.

Such indexes must be used with caution, but the Fraser index is not the only piece of evidence suggesting that the rule of law in the U.S. is not what it was. The World Justice Project uses a completely separate methodology to assess countries' legal systems. The latest WJP report ranks the U.S. 17th out of 97 countries for the extent to which the law limits the power of government, 18th for the absence of corruption, 19th for regulatory enforcement, 22nd for access to civil justice and the maintenance of order and security, 25th for fundamental rights, and 26th for the effectiveness of criminal justice. Of all the former British colonies in the report, the U.S. ranks behind New Zealand, Australia, Singapore, Canada, Hong Kong and the United Kingdom—though it does beat Botswana.

The decline of American institutions is no secret. Yet it is one of those strange "unknown knowns" that is well documented but largely ignored. Each year, the World Economic Forum publishes its Global Competitiveness Index. Since it introduced its current methodology in 2004, the U.S. score has declined by 6%. (In the same period China's score has improved by 12%.) An important component of the index is provided by 22 different measures of institutional quality, based on the WEF's Executive Opinion Survey. Typical questions are "How would you characterize corporate governance by investors and boards of directors in your country?" and "In your country, how common is diversion of public funds to companies, individuals, or groups due to corruption?" The startling thing about this exercise is how poorly the U.S. fares.

In only one category out of 22 is the U.S. ranked in the global top 20 (the strength of investor protection). In seven categories it does not even make the top 50. For example, the WEF ranks the U.S. 87th in terms of the costs imposed on business by "organized crime (mafia-oriented racketeering, extortion)." In every single category, Hong Kong does better.

At the same time, the U.S. has seen a marked deterioration in its World Governance Indicators. In terms of "voice and accountability," "government effectiveness," "regulatory quality" and especially "control of corruption," the U.S. scores have all gone down since the WGI project began in the mid-1990s. It would be tempting to say that America is turning Latin, were it not for the fact that a number of Latin American countries have been improving their governance scores over the same period.

What is the process at work here? Perhaps this is a victory from beyond the grave for classical Western political theory. Republics, after all, were regarded by most ancient political philosophers as condemned to decadence, or to imperial corruption. This was the lesson of Rome. Democracy was always likely to give way to oligarchy or tyranny. This was the lesson of the French Revolution. The late Mancur Olson had a modern version of such cyclical models, arguing that all political systems were bound to become the captives, over time, of special interests. The advantage enjoyed by West Germany and Japan after World War II, he suggested, was that all the rent-seeking elites of the pre-1945 period had been swept away by defeat. This was why Britain won the war but lost the peace.

Whatever the root causes of the deterioration of American institutions, smart people are starting to notice it. Last year Michael Porter of Harvard Business School published a report based on a large-scale survey of HBS alumni. Among the questions he asked was where the U.S. was "falling behind" relative to other countries. The top three lagging indicators named were: the effectiveness of the political system, the K-12 education system and the complexity of the tax code. Regulation came sixth, efficiency of the legal framework eighth.

Asked to name "the most problematic factors for doing business" in the U.S., respondents to the WEF's most recent Executive Opinion Survey put "inefficient government bureaucracy" at the top, followed by tax rates and tax regulations.

All this should not be interpreted as yet another prophecy of the imminent decline and fall of the U.S., however. There is some light in the gloom. According to the most recent United Nations projections, the share of the U.S. population that is over 65 will reach 25% only at the very end of this century. Japan has already passed that milestone; Germany will be next. By midcentury, both countries will have around a third of their population age 65 or older.

More imminently, a revolution in the extraction of shale gas and tight oil, via hydraulic fracking, is transforming the U.S. from energy dependence to independence. Not only could the U.S., at least for a time, re-emerge as the world's biggest oil producer; the lower electricity costs resulting from the fossil-fuel boom are already triggering a revival of U.S. manufacturing in the Southeast and elsewhere.

In a functioning federal system, the pace of institutional degeneration is not uniform. America's four "growth corridors"—the Great Plains, the Gulf Coast, the Intermountain West and the Southeast—are growing not just because they have natural resources but also because state governments in those regions are significantly more friendly to business. There are already heartening signs of a great regeneration in states like Texas and North Dakota.

"In America you have a right to be stupid—if you want to be." Secretary of State John Kerry made that remark off the cuff in February, speaking to a group of students in Berlin. It is not a right the founding fathers felt they needed explicitly to enshrine. But it has always been there, and America's leaders have frequently been willing to exercise it.

Yes, we Americans have the right to be stupid if we want to be. We can carry on pretending that our economic problems can be solved with the help of yet more fiscal stimulus or quantitative easing. Or we can face up to the institutional impediments to growth I have described here.

Not many economists talk about them, it's true. But that's because not many economists run businesses.

FOR MORE SEE MACRO ANALYTICS VIDEOS ON THE SUBJECT

CRONY CAPITALISM - Part II

RISK - Liquidity and Devious Public Policy Can Overcome Common Sense for only so long!

Liquidity Can Overcome Common Sense For Only So Long 06-13-13 Mark J. Grant, author of Out of the Box

Testifying before the British Parliament yesterday:

"Let's be clear. We've intentionally blown the biggest government bond bubble in history... If I were to single out what for me would be biggest risk to global financial stability right now it would be a disorderly reversion in the yields of government bonds globally," adding there have been "shades of that" in recent weeks.
 
              -Andrew Haldane, Bank of England Director of Financial Stability

Here may be the most open and truthful statement by any central banker since 2009. His comments indicate a number of things besides the first blush read. First and foremost it is an admission of global manipulation by all of the major central banks which is a position that I have expressed for quite some time. Mr. Haldane’s comments here and other remarks he made leave little doubt that the central banks have operated in collusion.
 
Second he flatly reinforced my long held opinion that the world has been living in the largest bubble in all of history. Every asset class, bonds, equities, commodities have been held up by the tremendous flow of liquidity created by these fellows. The world has been awash in capital and so much so that the liquidity overcame the economic fundamentals of the countries and markets that supported the prices and rationalized the levels. All of this was blown-out by the money that was created and put into the financial system with wild abandon.
 
So where do we stand today? First I think the “liquidity effect” is wearing off and secondly I believe that the economic fundamentals, far from improving, are rapidly getting worse.
 
Spain reported out its housing numbers this morning. Down the most since the Spanish agency began calculating the numbers. They dropped 6.6% in the last quarter and 14.3% from a year earlier. It is not just the Spanish bad bank but the securitizations at the ECB, guaranteed by Spain, that are bundled in a sea of red ink.
 
Then consider the promise of Japan’s central bank. An initial market reaction similar to the Draghi “Save the World” speech which has now deteriorated into a nightmare as the yen is pounded and their stock market gets hammered day after day. The Japanese hoopla has not matched the European hoopla by any stretch of the imagination. Their stock market was down 6.4% overnight which would equate to a 960 point drop for the Dow.
 
European sovereign yields are beginning to rise once again and you can sense a change of attitude in the marketplace.
 
Liquidity overcame common sense and economic fundamentals for a time. A lot of money was made and a huge amount of leverage was put on. Everything rose with the tide. Look around you though; look carefully.
 
I think the tide is beginning to go out. I believe recession in Europe will spread to America as the severity of the European crisis becomes more and more apparent. Upcoming economic data in France is also going to be quite troubling in my opinion and the contagion will become apparent in the United States.
 
You better watch out,

You better not cry,

Better not pout,

I'm telling you why
 
Santa Claus is about to head out of Dodge

EARNNGS - Tax Incentives Inflating Earnings

Behind the Big Profits: A Research Tax Break 06-14-13 WSJ

Strong first-quarter corporate profits may not be quite as good as they look.

An analysis by The Wall Street Journal shows that the extension of a big tax credit quietly boosted the profits of dozens of companies. Under accounting rules, the companies reported a year's worth of benefits from the research-and-development tax credit in their first-quarter results, lifting profits for many of them by more than 10%.

With first-quarter results nearly complete, 465 participants in the Standard & Poor's 500-stock index cumulatively reported that revenue increased 2.1% from the same period a year earlier. Expenses grew slightly faster, so pretax profit rose only 0.9%, according to the Journal's analysis.

But the S&P-500 companies also set aside 5.6% less money for taxes, and that helped their cumulative profits grow a robust 6.7%, the Journal found.

The biggest reason they took that action: the extension of the research credit and other tax breaks in January, said Jeffrey Hoopes, a lecturer in accounting at Ohio State University whose recent doctoral dissertation examined the issue.

For some companies, the effect was dramatic. Internet giant Google Inc. reported spending $6.8 billion on research and development in 2012, making it one of the nation's biggest corporate research spenders.

The company set aside less than half as much money for first-quarter taxes as it did a year earlier even as its pretax income increased 2%, to $3.6 billion. Its effective tax rate fell to 7.9% from 18.5%. In a securities filing, Google said the drop was "primarily" due to the extension of the tax credit. If Google's profit had been taxed at the same rate as last year, the company would have had to set aside an additional $380 million for income taxes.

"This tax credit was introduced over 25 years ago to stimulate innovation—and that's exactly what we use it for," a Google spokeswoman said.

The first-quarter tax rate of semiconductor maker Intel Corp. also declined, to 16.3% from 28.2%, in the 2012 first quarter. Intel reported $10.1 billion in research spending last year, more than any other publicly traded U.S. company. It said the "substantial majority" of the decline stemmed from extension of the research credit. If Intel's profits had been taxed at last year's rate, it would have set aside an additional $290 million.

Big companies cited a variety of reasons for reporting smaller first-quarter tax bills. In addition to the tax-credit extension, pharmaceutical maker Merck & Co. reported a $160 million benefit from resolving an old tax dispute between the Internal Revenue Service and Schering-Plough Corp., which Merck acquired in 2009. Insurance company Cigna Corp. said its tax rate declined because of changes to its reinsurance and disability businesses.

But extension of the research credit weighed heavily. The credit, which applies to increases in research spending, costs the federal government more than $7 billion annually, according to the Senate Finance Committee. First adopted in 1981, the credit has been extended 15 times, but it has never been made a permanent part of the tax code.

The previous extension expired at the end of 2011, meaning that companies couldn't claim the credit last year. That quietly increased tax rates—and hurt earnings—last year. Under the measure approved in January, the research credit will again expire at the end of this year, raising the prospect of future distortions in corporate earnings.

Research-heavy technology and pharmaceutical companies benefit most from the credit. In 2009, the latest year for which statistics are available, the Internal Revenue Service said that more than half the $7.7 billion in credit was claimed by companies in three industries:

• computer and electronics manufacturing,
• chemical and pharmaceutical manufacturing, and
• transportation manufacturing.

Within those industries, said Nirupama Rao, an economics professor at New York University, the bulk of the credits are claimed by the largest companies. "It's big corporate America," Ms. Rao said of the beneficiaries. "Small firms aren't profitable enough to get the credit."

For example, aircraft-maker Boeing Co. said that extension of the credit reduced its first-quarter income-tax provision by $145 million. Boeing's tax rate fell to 23.1% from 36.8% in the first quarter a year earlier. Boeing reported spending $3.3 billion on research and development in 2012.

It's unclear how well investors anticipated the additional tax benefits. The accounting implications were known when Congress approved the extension as part of a deal to resolve the so-called fiscal cliff on Jan. 1. But a spot check by Thomson Reuters found that, of a dozen big beneficiaries of the credit, analysts excluded the impact from their earnings estimates at only one: Texas Instruments Inc.

Looking ahead, the unusual benefit from extension of the tax credit won't help corporate profits for the rest of this year. Analysts surveyed by Thomson Reuters project that S&P 500 earnings will rise 2.7% in the second quarter, about half the growth rate of the first quarter.

"The effective tax rate we saw in the first quarter is not representative of what we'll see in the rest of the year," said Alex Morozov, head of the health-care analyst team at Morningstar.

Click to Enlarge

DIVERGENCES - Can Be Found Almost Everywhere

If Things Are So Great, Why Is This Chart So Bad? 06-13-13 Bloomberg Briefs via ZH

Just as during the Great Moderation, buying financials has become the no-lose trade for any and all momo junkies. From their 'fortress' balance sheets (prone to total leveraged collapse at any moment from giant over-zealous trades and mismarking of assets) to their 'can't lose' scenario analysis if rates rise because NIM will make them rich (aside from the fact that it won't), bank stocks have been among the best performers in recent months (dramatically outperforming credit in the last few weeks). So we have a simple question. If things are so great... if the outlook so rosy... if the price-to-book so misvalued... why are the bank laying off people in 2013 at a rate almost as fast as they did in 2009?

Financial institutions are firing staff at almost the same rate in 2013 as they did in the immediate aftermath of Lehman!

which perhaps explains this divergence...

Chart: Bloomberg Briefs

PATTERNS - Testing Critical Intermediate Term Trendline Support

The Two Charts That Have Central Bankers Terrified 06-13-13 Graham Summers www.gainspainscapital.com

Best Regards

Graham Summers

Japan continues to impode. We’ve now taken out the trendline that supported this rally since November.

Not a pretty chart. Certainly not a pretty chart for Central Bankers, who believe QE can drive stocks only up. After all, Japan’s Nikkei is in a bear market only two months after the Bank of Japan announced a record QE.

Speaking of trendlines, the S&P 500 is on the ledge of a cliff. Bernanke bought six months’ of market gains with QE 4. Now he’s got a bubble on his hands. And if he even hints at tapering QE at next week’s Fed meeting, the markets could implode.

Investors take note, the markets are sending us MAJOR warning signals. Indeed, I don’t remember seeing this many signs of a major top since 2007/2008.

We all know how that ended.

BONDS - Buy In June After the Swoon

Buy (Bonds) In June, After The Swoon? 06-12-13 Zero Hedge

In 2006, 2007, 2008 and 2009 we saw 10Y bond yields surge into June only to peak and turn lower aggressively; and in 2010, 2011 and 2012 we saw a 'mini rally' in yields into June that was not sustained, so, as Citi FX's Tom Fitzpatrick notes, while we regularly hear the mantra for the Equity market of "Sell in May and go away" maybe we should have one for the Bond market - "Buy in June after the swoon."

There can be no doubt that the predominant factor in rising yields, increased market volatility, turmoil in emerging markets, rising peripheral European yields etc. over recent weeks has been the Fed but Citi still believes that the mention in the past weeks of "tapering" has been a "Kite flying" exercise by the Fed with the premise being to sell 'the markets' on the idea that reducing bond purchases was a “slowing of easing”, a “tinkering” not a tightening.

It appears it is not going according to plan and we believe the Fed has got its answer as to what will happen if they announce tapering and it’s not pretty and unless they back away from this 'less easing' path, this policy mistake will have a negative feedback loop in financial markets and the economy leading to the market “easing” again and sending bond yields lower once more.

Via CitiFX,

...

So the argument from the Fed is that tapering is a slowing of the easing process rather than a tightening process. While mathematically that may be correct consumers do not borrow from mathematicians or for that matter at the “Fed funds rate”

The simple fact of the matter is that starting with the employment numbers in May combined with the tapering rhetoric from the Fed this rate has risen 71 basis (low to high) points since 01 May. If pushing mortgage rates lower is accepted to be a form of unconventional monetary easing (given we are looking to recover out of the greatest housing downturn of this generation) then rising mortgage rates have to be viewed as a tightening.

So to varying degrees we have seen a rising 10 year yield into June in the last 7 years. The most impulsive moves were seen in the four years 2006-2009. Those moves had characteristics more like what we have seen this year and in all cases we saw dramatic moves lower after a surge higher into June. Three of those four surges peaked between 11 and 13 June.

• 2006: 10 year yields surge and hit a peak of 5.25% on 28 June. That level is never again revisited that year and by December the yield had fallen to 4.40%
• 2007: 10 year yields surge and hit a peak of 5.32% on 13 June. That level is never again revisited that year and by November the yield had fallen to 4.05%
• 2008: 10 year yields surge and hit a peak of 4.27% on 13 June. That level is never again revisited that year and by December the yield had fallen to 2.03%
• 2009: 10 year yields surge and hit a peak of 4.00% on 11 June. That level is never again revisited that year and by October the yield had fallen to 3.10%
• 2010: 10 year yields were heading lower but have a short term bounce to peak at 3.42% on 03 June. That level is never again revisited that year and by October the yield had fallen to 2.33%
• 2011: 10 year yields were heading lower but have a short term bounce to peak at 3.22% on 30 June. That level is never again revisited that year and by October the yield had fallen to 1.67%
• 2012: 10 year yields were heading lower but have a short term bounce to peak at 1.73% on 11 June. A new trend low is posted at 1.38% on 25 July. The yield finishes the year at 1.75%

Bottom line the Fed is singing “Everything will be alright” while the market is singing “Hotel California” (You can check out anytime you like but you can never leave.)

Tapering will come, tightening will come but the “patient” is not yet healthy enough to take this shock just yet. To push this prescription at this point risks a relapse.

BONDS - A Flight to Safety from An EM Liquidity Crisis?

A Treasury bond buying opportunity triggered by an emerging market storm? 06-12-13 Currency Currents

As you likely know, there has been a lot of damage to emerging market stocks, bonds, and currencies on a relative basis compared t o the developed world markets. And you may remember that n ot too long ago emerging /developing market (EMs) finance minist ers were beating the drums of “ currency war. ” The b l ame placed squarely on the august shoulders of Mr. Ben Bernanke and company . The IMF was so concerned; they were openly endorsing the use of capital controls to help EMs to handle the pressure . We ll, maybe it ’ s just a cease fire, but EM finance ministers are now intervening to keep their currencies from “ depreciating. ” How quickly things can change?

Given the nature of emerging (or developing) world markets, and lack of any depth in their capital markets, i.e. bond markets, relative to the size of money flows from the center from i ndividuals and institutions escaping the zero interest rate regimes and looking for more, the ebb and flow of money can be seen by the track of EM stock market and currency markets. Keep in mind that o ne has to buy the currency to invest in l ocal stocks of an EM, and one has to sell the stocks and sel l the currency locally when one decides to leave. If there was a viable bond market locally, with assorted money market and derivative products available, we likely wouldn ’ t see the currencies so highl y correlated with local stocks . A good example of this can be seen in Brazil. N otice the correlation between the Brazilian real/USD cross and Brazil ’ s stock market in the daily chart below :

This price action in stocks and currencies has been playing out in many EMs lately. S o it poses a couple of questions:

1. As this money leaves EMs, where has it gone ?

2. Is this flow out of EMs a precursor to a nasty global growth accident ahead?

Wrestling with the first question and thinking abou t the actions in US Treasuries is a bit confusing.

Below is a chart comparing the Thomson R euters BRIC Stock Index (Brazil, Russia, India and China) versus US Treasury Bond Futures ... what I want you to notice here is th at usually when there is a sell - off in the BRIC index, US T reasuries ral ly and vice versa . But notice the action since the latest sell - off in the BRIC index, which began back in early May 2013 — instead or rallying on this price actio n, US Treasury bond prices fell, i.e. the price series moved in the same direction.

As JR and I think about this chart, it leads to an interesting set of scenarios. Some a bit more far - fetched than others; but here is what I am thinking:

This money flowing out of EM equities is flowing into US and other developed world equity markets. But, the danger here is two - fold: a) Given the deleveraging by European banks out of EM markets; there is a real poss ibility of a liquidity crunch, and b) a liquidity crunch in EMs would likely go hand and hand with a big sentiment shift regard ing global growth, i.e. it might Black Swan

Many market conflagrations have been ignited quietly in EMs before growing into a global &^#$ ( four lett er wo rd starting with “ s ” ) storm .

Could this be one of the m? Of course we don ’ t know. But, if a storm develops it means US Treasuries , as usual , will be the

BOND MARKET - Tremors Getting Louder

Bond Market Tremors Get Louder 06-11-13 Zero Hedge

It appears the cracks in the armor of the central bankers created by an over-enthusiastic BoJ's impact on the quadrillion JPY JGB markets are now rippling through the global market place. While every talking head that dares to speak has proclaimed the weakness in bonds as nirvana for equity bulls, it seems they were wrong, very wrong. As bond market tremors ignite everywhere, so equity markets come a little unglued at the prospect that the Fed, ECB, BoJ, and PBOC may not be so omnipotent after all...

Bond markets...

BOND SCARE - Mainstream Saying Bond Market HAS or IS Reversing Its Long Trend

SOCGEN: 'Are We Facing A Bond Crash? Not Yet, But...' 06-10-13 Socgen via BI

Recent moves in the US and Japanese bond markets have some people worried if interest rates are doomed to surge. The consensus certainly seems to think so.

Goldman Sachs' Francesco Garzarelli has warned clients that the bond sell is "for real" with 10-year Treasury yields likely to head to 2.5% later this year.

In a note to clients this morning, Societe Generale's Patrick Legland reminds clients that their analysts expect the 10-year Treasury surging to 2.75% by the end of the year.

Legland communicated this in a note titled "Are We Facing A Bond Crash? Not Yet, But..." In the note, he discuss the risk of a disorderly bond market sell-off. Here's the "but" explained:

More volatility: a worrying sign

The recent rise in bond volatility is clearly a worrying sign, but we are still far from the volatility peaks which occurred in the past five years following the Lehman debacle and the euro sovereign debt crisis. However, the sharp rise in Japanese yields reminds us that there is still an anomaly that should be corrected in the next few years. The key question remains whether the BoJ will succeed in its policy and be able to maintain rates at low levels medium term. If not, then the bond bubble could burst rapidly, with dire consequences for financial markets. The evolution of bond volatility in Japan and the US should therefore be watched closely for any signs of panic. For the moment, we do not see indications of an imminent bond crash, but volatility will remain high until we understand better how the Fed exit will be implemented.

So, the risk of a bond crash is not imminent, but certainly on the table.

EMERGING MARKETS - Feeling the US "Exportation" of Inflation

This Is Increasingly Looking Like An Emerging Market Bond Meltdown 06-10-13 BI

The massive sell-off across emerging markets continues in force.

One of the big themes in global markets over the past month has been the rise in U.S. Treasury yields and the attendant strength in the U.S. dollar. This has caused a big unwind in emerging markets, as EM currencies depreciate against the dollar and higher-yielding EM government bonds look less attractive relative to Treasuries.

The 10-year Turkish government bond yield rose 22 basis points to 4.22%. In South Africa, 10-year yields rose 28 basis points to 7.84%. And in Mexico, 10-year government bond yields widened 5 basis points to 3.33%.

And if you're looking for a really ugly chart, inflation linkers in Brazil are getting absolutely massacred. (Inflation linkers are just bonds linked to inflation, like TIPS in the U.S.)

VALUATIONS - Macro Trends in Wages and Profits

The Real Underpinning for Equities 06-11-13 Gavyn Davies, Financial Times

Global equities have, so far, survived the bout of global deleveraging which followed Ben Bernanke’s remarks about slowing the pace of QE last month, though there have been nasty signs of volatility in Japanese and some emerging markets. Investors have, unsurprisingly, become temporarily obsessed by whether the Fed will taper its asset purchases in September or December. However, in the great scheme of asset valuation, this is nothing more than a passing detail. In the longer term, what matters is real factors, like

1. The forward path for corporate earnings, and
2. The interest rate at which they should be discounted.

• The appropriate discount rate is the risk-free (real) bond yield plus the equity risk premium (ERP).
• The Fed acts on the former, while the market determines the latter.

In recent years, the Fed has reduced the bond yield but the market has, simultaneously, required a higher ERP, so

the overall discount rate on equities has remained broadly unchanged

• As I have argued before, any rise in the bond yield as QE ends may be offset by a fall in the ERP, leaving the valuation of equities protected as bond returns become negative.
• We have seen a minuscule version of this playing out in recent weeks, for what it is worth.

This, however, does not necessarily mean that equities are fairly valued.

A common concern among investors is that the profit share in the US economy is currently abnormally high, which is one reason why US equities have performed so well since 2009. It is frequently argued that the profit share must eventually “mean revert”, and when that happens the market will have to revise downwards its estimates of the sustainable path for corporate earnings. Equities will tumble, not because of a hostile Fed, but because the fundamental earning capacity of corporate America will be found wanting.

This, however, seems to underplay the persistence and global breadth of the rise in the profit share, and the accompanying decline in the wage share, in the last three decades. It is far from clear why this trend should “mean revert” in the foreseeable future.

The recent behaviour of the wage and profits share in the US is familiar territory for most investors.

After a century or more in which the profit share in GDP had fluctuated around a constant mean, the rise in the last few years has taken it above previous peaks, and the wage share has plumbed unprecedented depths. This has occurred because real wages in the US have grown much more slowly than output per head, which means that all of the gains from productivity growth have dropped into the hands of shareholders rather than workers.

I am certainly not making the case that this has been socially desirable, especially since the rise in real wages which has occurred has been concentrated at the very top of the income scale. The resulting change in the distribution of income and wealth is a major political issue (see David Blake’s penetrating analysis here), but from an investor’s point of view, it has provided a critical underpinning for rising share prices.

In the past, market economies have tended to erode unusually high profit margins through price competition which has restored real wages to their previous trends. That has always been seen as the natural order of things in a capitalist system. But there is no sign of it happening this time.

It is important to recognise that similar patterns have been seen not just in the US, but throughout the developed world, starting in the late 1970s [1].

In fact, the gross profit share in the advanced economies has risen by about 10 percentage points of GDP over three decades, and the wage share has fallen by the same amount (see this analysis just published by the International Labour Organisation, well summarised by Timothy Taylor here).

This is an enormous upheaval in the distribution of income in the global economy, and it has happened in an almost continuous straight line over the entire period. It seems to have been impervious to every kind of shock, including

• the decline in inflation,
• the technology bubble,
• the arrival of the BRICs,
• the collapse in the global financial system and
• two successive Ashes victories for England against Australia.

Not only has this pattern been repeated in almost every developed economy (though the UK and some of the less successful eurozone economies are partial exceptions over recent years), it has also been seen in the emerging economies as well.

This is even more surprising, since conventional trade theory (ie the Stolper-Samuelson theorem) predicts that the returns to the abundant factor of production, which is clearly labour in the emerging economies, should rise as more trade takes place.

The Stolper-Samuelson theorem (explained here) assumes that neither capital nor labour is mobile across borders. With capital increasingly mobile since the 1980s, the predicted rise in the wage share in emerging economies has not happened. What has happened instead is that the returns to capital have increased throughout the world, while the returns to labour have been severely squeezed. Workers have not had sufficient market or political power to prevent this.

The cumulative effect on corporate earnings, and therefore on equity markets, has been enormous. Consider the following. If the 10 percentage points decline in the wage share had not occurred, and everything else had (implausibly) stayed the same, then gross profits in the developed economies would have been about one-third lower than they are today and net profits (after depreciation) would have been about two-thirds lower. In addition, since the ILO reports that much of the income transferred from labour to capital has been used to pay increased dividends, the consequent rise in the dividend yield has probably been very large as well.

The conclusion is two-fold.

First, equity markets would indeed by very vulnerable if the decline in the wage share started to reverse on a permanent basis.

Second, that decline has been so widespread and persistent that it must have been caused by some very powerful and continuous economic forces, including

• a technology revolution,
• globalisation,
• financialisation and
• the erosion of labour’s bargaining power

—————————————————————————————–

Footnote [1]

The data for international economies relate to the “adjusted” wage and profit share, after excluding the self employed. The advanced economies are a GDP-weighted aggregate of the US, eurozone, Japan and the UK. The emerging economies are a simple average of Korea, Turkey, Mexico, Hungary and Poland. Source: EC Ameco database.

EARNINGS - Estimates Becoming Very Suspect

For Anyone Who Still Thinks Earnings Matter 06-10-13 Zero Hedge

As Mike Tyson once ominously noted, "everyone has a plan until they get punched in the face," and it seems the rampage of equity bulls have some plan that many more prosaic fundamental analysis-based investors are unaware of (as we showed here). The 'punch' in the face will come; but in the meantime the following chart may be just the 'jab' that softens them up. As ThomsonReuters notes, of the 116 second-quarter earnings preannouncements given by S&P 500 companies, 93 of them have been negative, while only 14 have been positive. The resulting 6.6 negative to positive guidance ratio is the most negative since the first quarter of 2001. Nothing to see here, move along.

Of course - that doesn't matter - as we already know... fundamentals are irrelevant in a market of expanding hope-driven multiples...

because margin 'faith' is keeping the dream alive...

Charts: Barclays and ThomsonReuters

(h/t Brad Wishak At NewEdge)

GOLD - JPM's Gold Vault Needs Watching

JPM Vault Gold Drops By 28.4% Overnight, Slides To Fresh Record Low As Withdrawals Accelerate 06-11-13 Zero Hedge

With a massive 6,208 (or 80% of the total in the entire Comex system) Customer Delivery issues outstanding against JPM so far in June alone, many have been wondering - how and when will the firm reconcile what is seemingly more demand for JPM vaulted gold than the firm has in its possession?

While we still don't have the answer, what we do know is that as of an hour ago when the Comex released its daily vault depository statistics, JPM has said goodbye to another 28.4% of all of its vaulted gold - the largest one day withdrawal since April 25, the result of the departure of 61.5% of its Eligible gold, as hundreds of thousands of registered ounces in the bast few weeks have seen warrant detachment.

Which means that as of last night, total gold held by JPM has fallen to a new fresh all time low of just 550k ounces, down from 768K the day before, and total eligible gold of only 136,380 troy oz in inventory (just over 4 metric tonnes) - also a record low.

Whoever is "running the JPM vault" shows no sign of relenting. At this pace, the world's biggest gold vault located below 1 CMP, and just next to the Fed's own gold vault, will be empty in about 1.5-2 months.

STATISM - A Short History of Big Brother Sam

How America Became Orwellian: A Short History of Big Brother Sam 06-09-13 Juan Cole at Informed Comment

Cora Currier, Justin Elliott and Theodoric Meyer write at
ProPublica

On Wednesday, the Guardian published a secret court order requiring Verizon to hand over data for all the calls made on its network on an “ongoing, daily basis.” Other revelations about surveillance of phone and digital communications have followed.

That the National Security Agency has engaged in such activity isn’t entirely new: Since 9/11, we’ve learned about large-scale surveillance by the spy agency from a patchwork of official statements, classified documents, and anonymously sourced news stories.

1978

Surveillance court created

After a post-Watergate Senate investigation documented abuses of government surveillance, Congress passes the Foreign Intelligence Surveillance Act, or FISA, to regulate how the government can monitor suspected spies or terrorists in the U.S. The law establishes a secret court that issues warrants for electronic surveillance or physical searches of a “foreign power” or “agents of a foreign power” (broadly defined in the law). The government doesn’t have to demonstrate probable cause of a crime, just that the “purpose of the surveillance is to obtain foreign intelligence information.”

The court’s sessions and opinions are classified. The only information we have is a yearly report to the Senate documenting the number of “applications” made by the government. Since 1978, the court has approved thousands of applications – and rejected just 11.

Oct. 2001

Patriot Act passed

In the wake of 9/11, Congress passes the sweeping USA Patriot Act. One provision, section 215, allows the FBI to ask the FISA court to compel the sharing of books, business documents, tax records, library check-out lists – actually, “any tangible thing” – as part of a foreign intelligence or international terrorism investigation. The required material can include purely domestic records.

Oct. 2003

‘Vacuum-cleaner surveillance’ of the Internet

AT&T technician Mark Klein discovers what he believes to be newly installed NSA data-mining equipment in a “secret room” at a company facility in San Francisco. Klein, who several years later goes public with his story to support a lawsuit against the company, believes the equipment enables “vacuum-cleaner surveillance of all the data crossing the Internet – whether that be peoples’ e-mail, web surfing or any other data.”

March 2004

Ashcroft hospital showdown

In what would become one of the most famous moments of the Bush Administration, presidential aides Andrew Card and Alberto Gonzales show up at the hospital bed of John Ashcroft. Their purpose? To convince the seriously ill attorney general to sign off on the extension of a secret domestic spying program. Ashcroft refuses, believing the warrantless program to be illegal.

The hospital showdown was first reported by the New York Times, but two years later Newsweek provided more detail, describing a program that sounds similar to the one the Guardian revealed this week. The NSA, Newsweek reported citing anonymous sources, collected without court approval vast quantities of phone and email metadata “with cooperation from some of the country’s largest telecommunications companies” from “tens of millions of average Americans.” The magazine says the program itself began in September 2001 and was shut down in March 2004 after the hospital incident. But Newsweek also raises the possibility that Bush may have found new justification to continue some of the activity.

Dec. 2005

Warrantless wiretapping revealed

The Times, over the objections of the Bush Administration, reveals that since 2002 the government “monitored the international telephone calls and international e-mail messages of hundreds, perhaps thousands, of people inside the United States without warrants.” The program involves actually listening in on phone calls and reading emails without seeking permission from the FISA Court.

Jan. 2006

Bush defends wiretapping

President Bush defends what he calls the “terrorist surveillance program” in a speech in Kansas. He says the program only looks at calls in which one end of the communication is overseas.

March 2006

Patriot Act renewed

The Senate and House pass legislation to renew the USA Patriot Act with broad bipartisan support and President Bush signs it into law. It includes a few new protections for records required to be produced under the controversial section 215.

May 2006

Mass collection of call data revealed

USA Today reports that the NSA has been collecting data since 2001 on phone records of “tens of millions of Americans” through three major phone companies, Verizon, AT&T, and BellSouth (though the companies level of involvement is later disputed.) The data collected does not include content of calls but rather data like phone numbers for analyzing communication patterns.

As with the wiretapping program revealed by the Times, the NSA data collection occurs without warrants, according to USA Today. Unlike the wiretapping program, the NSA data collection was not limited to international communications.

2006

Court authorizes collection of call data

Jan. 2007

Bush admin says surveillance now operating with court approval

Attorney General Alberto Gonzales announces that the FISA court has allowed the government to target international communications that start or end in the U.S., as long as one person is “a member or agent of al Qaeda or an associated terrorist organization.” Gonzalez says the government is ending the “terrorist surveillance program,” and bringing such cases under FISA approval.

Aug. 2007

Congress expands surveillance powers

Sept. 2007

Prism begins

The FBI and the NSA get access to user data from Microsoft under a top-secret program known as Prism, according to an NSA PowerPoint briefing published by the Washington Post and the Guardian this week. In subsequent years, the government reportedly gets data from eight other companies including Apple and Google. “The extent and nature of the data collected from each company varies,” according to the Guardian.

July 2008

Congress renews broader surveillance powers

April 2009

NSA ‘overcollects’

Feb. 2010

Controversial Patriot Act provision extended

President Obama signs a temporary one-year extension of elements of the Patriot Act that were set to expire — including Section 215, which grants the government broad powers to seize records.

May 2011

Patriot Act renewed, again

March 2012

Senators warn cryptically of overreach

In a letter to the attorney general, Sens. Ron Wyden, D-Ore., and Mark Udall, D-Colo., write, “We believe most Americans would be stunned to learn the details” of how the government has interpreted Section 215 of the Patriot Act. Because the program is classified, the senators offer no further details.

July 2012

Court finds unconstitutional surveillance

Dec. 2012

Broad powers again extended

Congress extends the FISA Amendments Act another five years, and Obama signs it into law. Sens. Wyden and Jeff Merkley, both Oregon Democrats, offer amendments requiring more disclosure about the law’s impact. The proposals fail.

April 2013

Verizon order issued

June 2013

Congress and White House respond

Following the publication of the Guardian’s story about the Verizon order, Sens. Feinstein and Saxby Chambliss, R-Ga., the chair and vice of the Senate intelligence committee, hold a news conference to dismiss criticism of the order. “This is nothing particularly new,” Chambliss says. “This has been going on for seven years under the auspices of the FISA authority, and every member of the United States Senate has been advised of this.”

Director of National Intelligence James Clapper acknowledges the collection of phone metadata but says the information acquired is “subject to strict restrictions on handling” and that “only a very small fraction of the records are ever reviewed.” Clapper alsoissues a statement saying that the collection under the Prism program was justified under the FISA Amendments of 2008, and that it is not “intentionally targeting” any American or person in the U.S.

Statements from the tech companies reportedly taking part in the Prism program variously disavow knowledge of the program and merely state in broad terms they follow the law.

STATISM - Why The Surveillance State Must Be Erased

Why The Surveillance State Must Be Erased 06-11-13 Brandon Smith of Alt-Market blog via ZH

In America today there is a great rushing storm, a swirling hurricane of clashing opinions and ideologies that defy coherent organization and classification.  This social tempest has been triggered by certain revelations among the general public on issues which we in the Liberty Movement have long been aware.  The fact that our government is bought and paid for by international corporate interests, the fact that our government has positioned itself to spy on ALL Americans without warrant and without probable cause, the fact that our government is instituting policy initiatives that target common citizens as enemy combatants, the fact that every one of our Constitutional rights is being deliberately torn away; these things are not news to us, but to many once ignorant people, they are a shock to the system.

Open corruption on the part of a criminal establishment has a funny way of politicizing everyone, even those people who go out of their way to avoid the bigger picture.  In the end, no man or woman gets a pass.  Whether you like it or not, one day soon, you will have to choose a side; freedom or tyranny.  There is no middle ground.  There is no Switzerland. 

With all the rationalizations and counter-rationalizations flying around concerning the current avalanche of admissions and data leaks, it is easy to lose track of the root of the overall conflict.  It’s as if we have been dropped into the heart of an Amazonian swamp, our feet encased in a thick sludge of social inaction as a dark cloud of mindless mosquito-people buzz about us, pecking hungrily at our veins with their warped and uneducated world views.  The deafening chorus distracts us from what is truly important.

Here is the reality of our situation:

1) Both the Bush Administration and the Obama Administration supported FISA domestic surveillance legislation.  FISA is the legal tool which the federal government now uses to justify the monitoring of journalists and recently exposed mass surveillance programs such as PRISM.  Politicians from both the Republican and the Democratic parties have defended the use of FISA and PRISM.  Both parties support the destruction of your 4th Amendment rights. 

2) The Obama Administration openly admits to the monitoring of journalists phone and email records in an attempt to thwart whistleblowers that might actually bring the truth of what the government is doing into the light of day.  Obama of course defends this position by claiming that “national security” is at stake.

3) Part of the motivation for surveillance measures against journalists has clearly been the Benghazi conspiracy, which is a thorn in the side of the establishment that refuses to go away.  Like Watergate, or Iran-Contra, the White House has been caught with its pants down and instead of admitting its guilt, has decided to attack the messengers instead. 

4) Another motivation was certainly the exposure of the ATF’s “Fast And Furious” program, which funneled U.S. firearms into the hands of Mexican drug cartels so that American firearms dealers and owners could be blamed for the escalation of deadly violence south of the border.  Again, Obama and his handlers seek to use a suffocating surveillance grid in order to thwart whistleblowers and prevent federal crimes from being aired in public.

5) The use of the IRS as a weapon against the political enemies of the establishment (namely Tea Party groups) verifies that government surveillance without oversight can indeed lead to political profiling and unjustified punishment.

6) The PRISM scandal, leaked by former CIA operative and NSA contractor Edward Snowden, has given the general public a raw naked look at the reality of the FISA spy initiative.  In the past, Liberty Movement champions have been derided as “paranoid” for pointing out that there were no limitations to FISA, and that the entire nation might one day be monitored and catalogued like animals in a great technological cage.  Today, the public now knows that this concern is concrete and undeniable.  EVERYONE is being watched.  Reports now estimate that NSA hackers harvest over 2.1 million gigabytes of data on American citizens per hour.

7) Privacy rights have been so debased that the invasion of our electronic communications is the least of our worries.  The Supreme Court has ruled in Maryland v. King that police now have the authority to extract DNA samples from any person placed under arrest, without a warrant, and without due process.  This means that the second a law enforcement officer places you in cuffs, your genetic materials are no longer your property, even if the charges against you are erroneous, if charges are ever filed at all.  The government admits to having at least 10 million people catalogued in their genetic database already.

8) Since 9/11, U.S. cities have added approximately 30 million new CCTV cameras on top of those already in operation.  After the Boston Bombing, even more are expected to be installed.  There are few places in most major cities where you are not being watched, and even smaller municipalities with miniscule crime rates are beginning to follow suit.

It would seem that our government has somehow overlooked the 4th Amendment of our Constitution, and statist rationalists would do well to study it before defending their actions.  Let’s read it, shall we?

The right of the people to be secure in their persons, houses, papers, and effects, against unreasonable searches and seizures, shall not be violated, and no warrants shall issue, but upon probable cause, supported by oath or affirmation, and particularly describing the place to be searched, and the persons or things to be seized.

Now let’s examine the arguments of the establishment in favor of the Surveillance State:

Argument #1:  Mass Surveillance Has Been Going On For A Long Time And Is Nothing New

Dianne Feinstein and Lindsey Graham, perhaps the most evil political duo since McCain and Lieberman, have both used the above talking point in order to rationalize the mass surveillance of FISA and PRISM.  But let’s put this in perspective…

Feinstein and Graham are essentially saying that because the government has criminally trespassed on our privacy for years, we should not complain when we discover that the invasion was a bit more elaborate than we had originally suspected.  They are saying that because we allowed them to get away with taking an inch, we might as well allow them to get away with taking a mile.  This is the logical fallacy of incrementalism, and tyrants use it in their arguments all the time.

Despotism rarely establishes itself overnight.  Rather, it slithers slowly into the midst of a society like a parasite, and carefully entrenches itself under our skin bit-by-bit so that we do not notice until it is buried so deep we fear removing it at all.  A line must be drawn in the sand eventually.  Past mistakes are not a license for future failures and future regrets, and anyone who claims otherwise is trying to take something away from you.

Argument #2:  If You’re Not Talking To Terrorists, Then You Have Nothing To Worry About

Another debate point from the bottom feeding Lindsey Graham.  First off, our Constitutional rights are not predicated on whether or not we are guilty of “terrorism”.  Even a so-called terrorist is supposed to be protected under the Bill of Rights.  The law is very clear, and this is not a negotiable position.  Every American, regardless of government suspicion, has a right to privacy, and is protected from unreasonable search and seizure without probable cause.  Period.  Graham’s argument perpetuates the fallacy that the word “terrorism” is somehow a magical password that allows the federal government to bypass Constitutional barriers.  I’m sorry to tell Lindsey that he is greatly mistaken.

Secondly, the very foundation of a free society requires that every person be treated as INNOCENT until proven guilty.  Mass surveillance twists this principle, so that all people are treated by the state as guilty until proven innocent.  Such a system will inevitably generate a vast rift between the populace and the government because it designates the political elite as the “watchers” and the public as the “watched”.  As history has shown us, the "watchers" always become the enslavers, and the "watched" always become the enslaved.   

I’m not sure why so many people, including U.S. senators, do not seem to grasp this concept.    

Argument #3:  We Must Trust That The Government Is Using The Surveillance Apparatus For Good

Barack Obama in defense of the leaked PRISM initiative and all encompassing NSA surveillance stated that Americans must simply “trust” that the federal system is using the data they have criminally harvested for the good of the country.  That is to say, we should have “faith” in the White House. 

I’m sorry, but the Constitution was written exactly because governments are run by men, NOT benevolent gods, and men are notorious for abusing power.  The Constitution exists because NO government can be trusted to act in a principled manner.  We do not have to “trust” them because tight constitutional restrictions are in place to ensure that they aren’t given enough slack to become dangerous.  When those restrictions are diminished, we get programs like PRISM…

The checks and balances of due process and warrants are supposed to be absolutely public and transparent so that we can see, with our own eyes, that all is being handled justly and honorably.  Mass surveillance in particular is an affront to the 4th Amendment because there is no conceivable way that warrants could ever be issued for the incredible volume of materials gathered, and therefore, there is no conceivable way that any legitimate judicial oversight is being enforced.  Secret courts, secret charges, secret programs targeting entire subsections of the population, were expressly forbidden by the Founding Fathers as totalitarian in nature.

In February of this year, Obama boasted during a Google Plus “Fireside Chat” that his was “the most transparent administration in history”.  The ability of politicians to lie with sociopathic expertise is well documented, hence, my lack of faith.

The government and the Obama White House in particular do not deserve our trust.  Trust has to be earned…

Argument #4:  Surveillance Programs Are Essential To The Safety Of The Public

At this point I find that anyone who still uses the “safety” position to justify the trampling of our freedoms is a lost cause.  Years ago, when the surveillance grid was being put into place through legal chicanery, the common skeptic would insist that such subversive laws had not yet hurt anyone, and that the concerns of the Liberty Movement were “overblown”.  Today, it’s no longer about theory.  Our cultural pain is real, people are being targeted, people are suffering, and it’s only going to get worse from here on.  And, as we warned a long time ago, the concept of “collective safety” would be the primary persuasion technique used to lead America further into oblivion.    

In a race to spin the leak of PRISM, lawmakers and establishment shills have come out in droves to suggest that the secret surveillance state has “stopped terrorist attacks” and “saved lives”.  Of course, because all the details of the program are classified, we’ll never see any proof that such claims are true.  What a conundrum.  Frankly, I know enough about government sponsored terrorism to understand that even if PRISM thwarted an attack, our clandestine alphabet bureaucracy has created far more death and destruction than they have ever prevented. 

In the end, I couldn’t care less if PRISM stopped a terrorist act.  The point is irrelevant.  Our civil liberties are not subject to the supposed success of an unconstitutional government action.  The promise of safety does not nullify our rights, nor does it give government capital to do whatever it pleases. 

Comfort Means Death

I believe the establishment has moved away from the denial of so many abuses because it hopes to convince us that this is the “new normal” of our society.  They want us to embrace the surveillance state and become comfortable in its cradling arms.  I do not plan to get “comfortable”.  When political villains no longer fear the exposure of their villainy, it is time to start worrying. 

There has been a lot of unrestrained conjecture on the motivations of the suddenly world-famous Edward Snowden.  The fact is we still know very little about him, and for now I will reserve judgment; partially because I know that one day people like myself could be accused of “fomenting controlled opposition” or “working for the enemy”.  Our culture has become so cynical that we refuse to believe that anyone does anything anymore out of a sense of principle. 

Whatever Snowden’s original intentions, I find his admitted reasons inspiring.  When asked why he forced the truth of PRISM into the mainstream, Snowden replied:

"I don't want to live in a society that does these sort of things ... I do not want to live in a world where everything I do and say is recorded. That is not something I am willing to support or live under…"

"I'm willing to sacrifice all of that [career and former life] because I can't in good conscience allow the U.S. government to destroy privacy, Internet freedom and basic liberties for people around the world with this massive surveillance machine they're secretly building."

"My sole motive is to inform the public as to that which was done in their name and that which is done against them…I understand that I will be made to suffer for my actions. I will be satisfied if the federation of secret law, unequal pardon and irresistible executive powers that rule the world that I love are revealed even for an instant."

The surveillance machine is the key to control.  When each person feels the eyes of the state constantly upon them, dissent and rebellion becomes unthinkable.  At the very least, those of us who are aware of the great Orwellian shift before us must take an immovable stand. 

The right to privacy is an inherent right of natural law. No individual or government system should be allowed legal precedence to invade my privacy, and all people have the right to be treated as innocent until proven guilty rather than guilty until proven innocent. As an individual, I do not owe the collective, or the government, a constant update on whether or not I am a "threat". In fact, I don't owe anyone anything.

If someone continues to treat me as an enemy and constantly tramples my natural right to privacy, I am going to fight them, and I am going to hurt them, perhaps mortally. This is what people who support surveillance society need to understand; there will be consequences for their trespasses against the natural rights of others.

There can be no negotiation.  There can be no compromise.  The surveillance state must be erased.

CURRENCY WARS - A Major Shift

"Tapering" From Currency-Wars To Interest-Rate-Wars 06-12-13 Citi's Steve Englander via ZH

"The opposite of currency wars is not necessarily currency peace; it can easily be interest rate wars," is the warning Citi's Steve Englander sends in a note toda, as EM and DM bond yields have relatively exploded in recent weeks. The backing up of yields represents an increase in risk premium, so this will likely have negative effects on asset markets and the wealth effect abroad as well. It is difficult to explain the magnitude of the yield backup in terms of normal substitution effects, and broadly speaking, if you were to compare the backing up of bond yields with the beta of the underlying economy and asset markets there would be a good correspondence. So, Englander adds, it is fear, not optimism that is driving bond markets.

Via Steven Englander,

The opposite of currency wars is not necessarily currency peace; it can easily be interest  rate wars.  Since May 1 the median increase in 10year local bond yields in 47 major EM and developed markets (DM)  is 39bps. Among major EM economies (light blue) it  is 83bps; among major DM (dark blue) economies it is 29bps. The US 10year Treasury yield increase (red)is only at the median of developed economies and well below the overall median. In both EM and developed economies, the fat tail of rate increases is to the upside, so average increases are even higher. The paradox is that the run-up in US interest rates, which is arguably the primary driver of these global rate increases, is well below  the average and median globally.

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Even if we assume that the GDP-weighted average increase in yields is about 30bps, it represents a significant tightening in global economic conditions. The inflation picture has not changed materially in the last six weeks; if anything, it may be more benign than earlier thought. On a global level, exchange rates cancel out and do not affect the effective stance of monetary conditions to a good first order approximation. We may argue that the US rates increase is justified by the improved US economic outlook, and some will debate even that.

However, the US represents about 20% of global GDP, and outside the US there have been very few calls for monetary policy tightening. As a consequence roughly 80% of the world has experienced a monetary policy tightening that was neither expected nor desired.

There is a rule of thumb  that 100bps of tightening at the short end translated into 20-30bps of tightening at the long end. If we invert that rule and use 30bps as the global average monetary tightening at the long end, then we have experienced the equivalent of 90-150bps of monetary tightening at the short end. If, given the skew, the effective increase at the long is closer to 40bps, we are looking at the equivalent of 120-200bps of short-end tightening. That is a lot, given that EM has been underperforming all year, and euro zone, japan and UK growth on the whole are not registering major upward surprises.

The backing up of yields represents an increase in risk premium, so this will likely have negative effects on asset markets and the wealth effect abroad as well. It is difficult to explain the magnitude of the yield backup in terms of normal substitution effects, and broadly speaking, if you were to compare the backing up of bond yields with the beta of the underlying economy and asset markets there would be a good correspondence. So it is fear, not optimism that is driving bond markets.

This backing up of yields is spilling over into exchange rates, although the correspondence is less than 1-1. In Figure 2 countries are ordered by the magnitude of their depreciation. By and large countries with bigger depreciations have experienced bigger increased in bond yields, although India and Australia stand out as exceptions on one end, and Hungary on the other. The backing up of yields in the euro zone periphery at some point may become a problem, as this adds to growth headwinds. The fact that this backing up is driven by global forces, not sovereign risk concerns does not make it less negative.

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It is tempting to say that DM and EM countries facing bond market pressure should just ease monetary policy further and take the hit on the exchange rate, so that effective monetary conditions are eased. Easing in response to the US-bond-market-induced monetary tightening is not feasible for many central banks. The ECB sees itself as having limited policy room now. The impact of BoJ’s easing has been undermined tremendously by the backing up of risk premia and implied volatility, and consequent softening of asset markets. EM is constrained in easing 1) because inflation may respond much quicker than output growth to a significant depreciation, and 2) there is some evidence that depreciations are now translating into further pressure on bond markets, undermining the effectiveness of ease. So bond wars may not be any more pleasant than currency wars.

The upshot is that we may continue to see pressure on commodity and EM currencies until asset market conditions stabilize. We continue to distinguish between higher levels of rates and higher levels of rate and asset market volatility. If US bond markets were to stabilize at current or even higher levels, but be accompanied by lower volatility, then other countries may be able to introduce offsetting macro policies. However, as long as the backing up of bond yields is accompanied by the higher volatility in asset markets, they are likely to find their policy options very constrained, and their asset markets under continuing pressure